SEI Forward

Hi, I'm Jim Smigiel, SEI's Chief Investment Officer here with another installment of "SEI Forward." Market Volatility is back with a vengeance as the long awaited tariff announcements from the new US administration have far exceeded even the most extreme expectations and have rightly left most investors wondering, what's next? To better understand the market's recent reactions, let's spend some time reviewing the details. 

On April 2nd, president Donald Trump unveiled his approach to tariffs, which very surprisingly focused on country's trade balances with the US as opposed to actual tariff rates. More specifically, the assumed tariff rate charged by other countries to the US, which set the retaliatory rate was actually a measure of each country's trade balance as a percentage of its exports to the United States. Very simply, the calculation was a country's imports from the United States minus exports to the US to arrive at a country's trade balance, then divide the whole thing by the country's exports to the United States. 

Let's take Vietnam as an example. In US dollar terms, Vietnam exported roughly $13 billion in goods to the US last year and imported roughly 1 billion. The trade balance was therefore minus $12 billion, which is roughly 90% of exports. It's important to walk through how these assumed tariff rates are being calculated so we can better understand the possible next steps for the countries affected. In other words, what is the goal and what may be the final outcome? Consider, for example, if the US focused on the actual tariff rates, other countries imposed on imported US goods, in this scenario, possible paths forward are pretty obvious. Countries could lower their tariff rates or accept reciprocal tariffs from the US. The terms of the negotiations are pretty clear. On the other hand, under the current approach, a country cannot simply decide to close their trade balance with the US overnight. In most cases, these trade balances are results of comparable advantages between one economy and another, and on trade arrangements that have been built over decades. 

In short, if the goal is to reduce actual tariff rates, that can be done very quickly. If the goal is to have flat or positive trade balances around the globe, that is something that will take years to achieve. So the market is now attempting to discount all of the future possible outcomes from this tariff approach, and has been pricing in the increased probability of lower global growth, including an increased recession risk and higher global inflation. The added challenge here is that the catalyst for all of this volatility is policy, and as we've seen, policy can change substantially with a single social media post. So while uncertainty is the only certainty of the capital markets, investors are rightly asking, how do we adapt? 

The answer may be unsatisfying in its simplicity, but we believe it is the correct approach, and that answer is to play the long game. The long game involves maintaining a globally diversified portfolio at an appropriate risk level that is robust enough to withstand multiple economic environments. The long game also involves avoiding significant portfolio allocation changes in reaction to market volatility. 

That said, this is actually a good time for an investment checkup to ensure that portfolios are properly diversified. Here are three questions that you can ask to determine if you portfolio has the proper amount of diversification. The first is, are you taking a global approach? Avoiding a home country bias, particularly in equity markets, is an excellent way to diversify your growth oriented assets. Specifically for those investors in the United States, which already makes up a huge percentage of the equity market. Geographic diversification can be extremely helpful in building a diversified portfolio. 

The second question is, do you have some inflation sensitivity? Nominal bonds like treasuries and corporates tend to underperform in inflationary environments. While equities can face headwinds from potentially lower margins, adding some form of inflation sensitivity such as commodities or inflation linked bonds to a strategic portfolio can provide some beneficial economic regime diversification. 

The last question, are you over allocated to passive management? Many industries, particularly in the United States, have become extremely concentrated and to just a few names and a few sectors. Adding some active management in these areas can further diversify a portfolio from a bottom up perspective, we understand that these are challenging times. We also do believe that there will be calmer times ahead later in the year as the US administration's current goals become clear and negotiations begin. In the meantime, a diversified portfolio remains the best approach. Thank you as always, for your trust and confidence.